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The financial system or the financial sector of any country consists of




The financial system is concerned about money credit and finance- the term intimately
related yet different from each other.

Money refers to the current medium of exchange or means of payment.

Credit or loan is a sum of money to be returned normally with interest.

Finance is the monetary resource comprising debt and ownership funds of the company or


They are business organization that acts as an mobilizer & depositaries of saving, mode of
credit and finance. They also provide various financial services to the community. Financial
institutions are the business & org. Involved in the collection & distribution of money. They
develop the methods and procedures that allow them to collect money from depositors and
lend it to borrowers. They develop the financial securities and provide the financial market
where lenders, borrowers, investors, speculators, and hedgers can exchange money for future
payments in the form of interest, for ownership interest such as stocks ,for sharing risk. This
pooled money is then given as loans or as investment to businesses and other organization to
finance specific projects or to provide financing for other needs.

Business make money by supplying products & services that are desirable and the more
desirable the product and services the more money that the business can earn and thus the
greater are the returns on the investments in the business. in their desire to earn greater return
financial institution help to funnel money to the most successful business , which allow them
to grow faster and supply even more desirable goods and services. This is how financial
institution greatly contributes to the efficient allocation of economic resources. Hence
financial institutions are also financial intermediaries.
Classification of financial institutions:-

1 Banking and non banking

2) Intermediaries and non intermediaries


The distinguish between the two has been highlighted by the Sayers by characterizing the
former has creator of credit and the latter has mere purveyors of credit .
Examples of banking institutions are : commercial banks and cooperative banks Examples of
non-banking institutions are :LIC;UNIT TRUST OF INDIA;IDBI


The financial institutions are also classified as intermediaries and non intermediaries. As the
term indicates, intermediaries intermediate between ultimate savers & investors; they lend
money as well as mobilize savings; their liabilities are towards the ultimate savers, while
their assets are from the investors or borrowers. All banking institutions are intermediaries
Non intermediaries institutions do the loan business but their resources are not directly
obtained from the savers. e.g.: UTI; LIC; GIC


Financial markets are the centres or arrangements that provide facilities for buying and
selling of financial claims and services. The corporations, financial institutions, individual
and government trade in financial products on these markets either directly or through
brokers and dealers on organized exchange or off exchange.

Classification of financial market:


The primary market deals in the new financial claims or new securities and therefore
they are also known as the new issue market.
The primary market mobilize the savings and they supply fresh or additional capital to
business units On the other hand secondary markets deals in securities already issued
or existing or outstanding. Secondary market do not contribute directly to the supply
of additional capital, they do so indirectly by rendering securities issued on the
primary markets liquid. Stock markets have both primary and secondary market


Both perform the same function of transferring resources to the producer. The money
market deals in short term claims (with period of maturity of one year or less),
example of money market- t bill market, call money market & commercial bill
market. The capital market does in long term claims (with period of maturity above
one year), example of capital market-equity market, debt market.


Financial system deals in financial services and claims or financial assets or financial


The financial assets represent a claim to the payment of a sum of money sometimes in
future (repayment of principal) or a periodic (regular or not so regular) payment in the
form of interest or dividend


They are classified as primary (direct) and secondary (indirect) securities. The
primary securities are issued by the ultimate investors directly to the ultimate savers
as ordinary shares and debentures, while the secondary securities are issued by the
financial intermediaries to the ultimate savers as banks, insurance policies and so on.


1) Efficiency:-

Focus of efficiency is on non- wastefulness of factor use & the allocation of factors to most
socially purpose.

Five concepts are useful in judging the efficiency

a) Information arbitrage efficiency :-

Degree of gain possible by the use of commonly available information.
Efficiency is inversely related to this type of gain. For example: - If one can make large
gains by using commonly available information, financial market is said to be inefficient.

b) Fundamental Valuation efficiency :-

When the market price of a security is equal to its intrinsic value or
investment value, the market is said to be efficient.

c) Full Insurance efficiency :-

It indicates the extent of hedging against possible future contingencies. The
greater the possibilities of hedging & reducing risk , the higher is the market

Functional / operational efficiency :-

The market which minimize administrative & transaction cost & which
provides maximum convenience to borrowers & lenders is said to be
operationally efficient.

d) Allocation efficiency :-
When financial markets channelise resources into those investment
projects & other uses where marginal efficiency of capital adjusted for risk
difference is highest, they are said to have achieved this efficiency.


Innovation means:-

 Introduction of new financial instrument.

 Introducing new use of funds.
 Finding out new sourcing of funds.
 Introducing new process or technology.
Financial innovation encompasses wide ranging changes in financial system & they also have
wide ranging effects. They lead broadening, developing, diversification, internationalization

It means development of new financial technology to cope with financial
changes. It involves construction, designing , deconstruction & implementation of innovative
financial institution.

For example: - Creation of financial derivation , & securitization.


The concept of financial revolution is the extension of the concepts of financial

innovation & engineering. The innovation in computers & satellite communication, & the
linking up of the two have completely changed the production, marketing and delivery of the
financial products.


It means the existence or the development of a very wide variety of financial

institutions, markets, instruments, services & practices in financial system.

It refers to the presence of opportunities for investors to purchase a large mix or

portfolio of varieties of financial instruments.

With the diversified portfolio investor can minimize the return for a given rate of
return or they can maximize the return for a given risk.


It refers to the phenomenon of a decline in the share of financial

intermediaries in aggregate financial assets in the economy because people switch out of their
liabilities into direct securities in the open market.


It represents the economic conditions in which government’s regulatory &

discretionary policies distort financial prices or interest rates, discourage saving, reduce
investment & misallocate financial resources.


Financial reforms include instituting policies which will increase the allocative
efficiency of available saving, enhance the health stability, profitability, viability of the
financial institutions.


It is regarded as a necessary part of financial reforms. It means increasing the

ownership, management & control of the financial sector by individual & private
incorporated & unincorporated bodies. This may be achieved partly by denationalization,
disinvestment by the state, allowing private sector entry and abstaining from new ownership
by the state.


The term indicates the extension of activities of a financial system beyond the
national boundaries. The extension may take place in the form of borrowing as well as
lending, and it may take place through official or private or commercial channel.

In the process of internationalization, the domestic financial institution participates in

foreign financial markets, and the foreign institution participates in domestic markets to a
significant extent.

In other words domestic & financial markets get integrated & interlinked.

There is a difference between internationalization and globalization.

Internationalization is used to indicate absence of regulation or control of any national

authority on financial markets.

Globalization refers to establishment of interlink age among national markets as a

result progressive liberalization & the removal of exchange control.


There has been a considerable transformation in the perception

regarding the roles of different financial institutions. Commercial banks are no longer
expected to advance only self liquidity short term credits. They are now required to adopt a
ongoing concern approach rather than a liquidation approach in their loan business.
Statutory financial institutions which were setup to provide long term funds to the private
sector & public sector units. Public sector units now raise large amount of funds directly from
the capital markets through bonds and deposits.

Such changes have been accompanied by changes in performance criteria also. For sometime,
an increase in social welfare & meeting requirement of social justice & sartorial balance
formed the basis of policies adopted by financial institution.


The reforms have had a broad sweep encompassing operational matters, banking,
primary and secondary stock markets, government securities market, external sector
policies and the system as a whole. while presenting a list of reforms, I t needs to be
pointed out that sometimes a distinction between normal policy changes which are
specific to time and economic conditions and reforms means to make or become better
by the removal of faults or errors or abuses. The former are included in the latter.it is
primarily in this sense that the major reforms are listed below in terms of certain







 Most of the interest rate deregulated, a beginning made to move towards market rates
on government securities.
 The SLR on incremental net domestic & time liabilities of banks reduced from 38.5%
to 25% in 1991-92
 A board of financial supervision with an advisory council established in RBI to
supervise all India financial , non banking financial institutes & banks
 The policy of permitting foreign banks to open branches liberalized
 The RBI act 1997 passed requiring all non bank financial companies with net owned
funds of RS 25 lakhs and more to register with the RBI.
 Capital issues act 1947 repealed and the office of controller of capital issues
 Recovery of debt due to banks and financial institution act 1993 set up special
recovery tribunals to facilitate quicker recovery of loan arrears


 Interest rates on deposits and advances of all co-operative banks deregulated.

 Banks were allowed to set their own interest rate on post shipment export credit in
rupees for over 90 days.
 Banks given greater freedom to open, shift & swap branches as also to open extension
 Banks required to make their balance sheet fully transparent and make full disclosure
in keeping with international accounts standard committee
 The performance Obligation and Commitments (PO&C) obtained by RBI are meant
to ensure a high level of portfolio of quality so that problems such as heavy losses,
low profits do not occur.
 The non fulfillment of PO&C entail penalty in the form of higher CRR/SLR, stoppage
of RBI refinance facility, stoppage of further capital contribution by the government.
 Banking ombudsman scheme 1995 introduced to appoint 15 ombudsmen to look into
& resolve customers grievances in a quick and inexpensive manner


 Issuers allowed to list the debt securities on stock exchanges without their equity
being listed.
 The stock exchange are being modernized.
 Both short and long sales are required to be disclosed to the exchange at the end of the
each day.
 The BSE & other exchanges with screen based trading system allowed to expand tier
terminals to locations where no stock exchange exists


 A 364 – day treasury bill replaced the 182- TB in 1992-93 , and it is being sold
fortnightly auction since april 1992.
 Auction of 91- day TB commenced from january 1993.
 Maturity period for new issues of Central Goverment securities shortened from 20 to
10 years and that for State Goverment from 15 to 10 years.
 Six new instrument introduced :
a ) Zero coupon bonds on 18.1.94

b ) Tap stock on 29.7.94

c ) partly – paid government stock on 15.11.94

d ) An instrument combining the features of tap and partly – paid stocks

on 11-09-1995.

e ) Floating rate bonds on 29-9-95.

f ) Capital indexed bonds in 1997.

 State Government and provident funds allowed to participate in 91-day TB auction on

a non – competitive basis from August 1994.
 A scheme for auction of government securities from RBI’s own portfolio as a part of
its open market operations announced in March 1995.
 Reverse repo facility with RBI in government dated securities extended to Discount
and Finance House of India (DFHI) and Securities Trading Corporation of India


 Flexible exchange rate system introduced and exchange control largely dismantled.
 Foreign Institutional Investors (FII) allowed acess to indian capital market on
registration with SEBI.
 Indian companies permitted to acess international capital markets through various
instruments including euro-equity issues.
 The union budget 1997-98 proposed the replacement of foreign exchange regulation
act (FERA), 1973 by a foreign exchange management act (FEMA) to facilitate easy
capital flows.
 Rupee made convertible on current account and a considerable progress made in
introducing capital account convertibility.
 Rate of long term capital gains tax on portfolio investment by NRIs reduced from 20
% to 10 % and brought on par with the rate for FIIs.
 RBI made a single – window agency for receipt and disposal of proposals for overseas
investments by Indian Companies.
 The foreign Investment promotion board (FIPB) reconstituted and foreign investment
promotion council (FIPC) set up to promote foreign direct investment in India.


The reform process appears to have yielded some results that may be positive as well as

Impact of reforms are of two types :-

• Positive

• Negative

Reform process appears to have yielded some positive results:-

 Relatively cleaner balance sheet

 There is a Reduction in Non – performing assets (NPAs)
 There seems an improvement in operating profits
 Fairly good progress in attaining capital adequacy ratio
 Market based exchange rate system has helped to open up the Indian economy to
integrate with rest of the economy.
 Non banking financial intermediaries have experienced an imperceptible
improvement after reforms.


 The Volume of fresh capital raised on the primary stock market has declined
 Secondary market reforms have not really progressed.
 Stock markets are plagued by uncommonly high number of drawbacks, weakness, and
malpractices and so on.
 Both primary and secondary market remains depressed.
 Exchange rate becomes more volatile.
 Performance of urban & other co-operative banks has deteriorated even in terms of
assets & profitability.

Management of Commercial banks: -

These are the profit seeking institutions which accept deposits from general public and
advance money to people like businessmen , entrepreneurs etc. with the prime objective of
earning profit in the form of interest ,commission etc.

They generally finance trade & commerce with short term loans. They charge high rate of
interest from their borrowers and pay much less rate of interest to their depositors. The
difference between these two rates becomes their main source of income.

Examples of commercial banks – SBI, Canara Bank, Punjab National Bank etc.

These commercial banks are also called joint stock banks because they are organized as joint
stock companies.

Functions of commercial banks:-


1. Accepting deposits: since it is a dealer in short term credit, the first task is collection
of the savings of public by accepting the following deposits:

• Fixed term deposits: these are time deposits and can be withdrawn only after
the expiry of specified period of time ranging from 1 day to n no. of years.
• Current a/c deposits: these carry no rate of interest and can be withdrawn at
any point of time by the depositors. These are generally preferred by
• Recurring deposits: a depositor can deposit a fixed amount, say RS. 100 for a
fixed period of time.
• Sving a/c deposits: these are suitable for individual household and the main
objective is to save.
2. Lending: - a second major function is to give loans and advances and thereby earn
interest on it. This function is the main source of income for the bank.
• Overdraft facility: a customer having current a/c is allowed to with draw more
than he has deposited and interest is charged on the amount actually
withdrawn by him.
• Cash credit : under this arrangement, a customer is allowed to withdraw a
certain sum of money on a given security(current assets & other securities)
• Loans & advances: a bank offers various types of secured and unsecured loans
but generally bank people prefer to give loan against some kind of security.
• Discounting of bill of exchange: in case a person wants money immediately,
he/she can present the B/E to the respective commercial bank and can get it


1. agency functions : bank act as a agent of its customers and get commission for
performing agency functions such as:
• transfer of funds
• Collection of funds through bills, cheques etc.
• payment of taxes , bills
• purchase & sale of shares & securities
• collection of dividend or interest
• acts as trustee & executor of properties
• letters of references
2. general utility services:
• locker facility
• purchase & sale of foreign currency
• Issues gift cheques,traveller’s cheques etc.
3. credit creation :
It is one of the most outstanding function of commercial banks . a bank creates credit on
the basis of its primary deposits. FOR EXAMPLE:
Suppose a person MR. A deposits 1000 rupees with the bank. Bank on the basis of its
experience knows that the depositor is likely to withdraw only 20% of his deposit i.e.
RS.200 and so the bank can advance the remaining Rs. 800 to another person say MR. B.
again 20% of B’s deposits , which is considered a safe limit is kept for him by the bank
and the balance rupees 640 is advanced to another person MR. C. in this way, the process
of credir creation goes on .

Classification of commercial banks :

 Non scheduled commercial banks

 Scheduled commercial banks

• Non scheduled commercial banks :- are those banks which are not included in
the Second Schedule of RBI Act 1934.

• Scheduled commercial banks :- are those banks which have been included in the
Second Schedule of RBI Act 1934. Scheduled commercial banks are divided into
three parts:

 Public Sector Banks :- are those banks in which majority of stake is held by the
government. Eg. SBI, PNB, Syndicate Bank, Union Bank of India, etc.

 Private Sector Banks :- are those banks in which majority of stake is held by
private indivisuals. Eg. ICICI Bank, IDBI Bank, HDFC Bank, AXIS Bank, etc.

 Foreign Banks :- are the banks with Head office outside the country in which
they are located. Eg. Citi Bank, Standard Chartered Bank, Bank of Tokyo Ltd.,
Management of commercial banks :

 Balancing Profitability with Liquidity Management

 Interest Rate Risk Management

 Credit Risk Management

 Asset - Liability Management

• Balancing Profitability with Liquidity Management :- the objective of commercial

banks is to make profits. But they have to balance the principal of profit maximization
with certain other principles. Thus, they need to pay much more attention to balancing
profitability with liquidity. All businesses have to devote considerable attention to
liquidity manaement but with banks thr need for maintenance of liquidity is much
greater because of nature of their liabilities. That is why, for banks liquidity
management is as important as profitability management. This is reflected in the
management and control of reserves of commercial banks.

• Interest Rate Risk Management :- IRR is the risk where changes in market interest
rates might adversely affect a bank’s financial condition. The banks lending, funding,
and investment activities give rise to IRR. The immediate impact of variation in
interest rate is on bank’s net interest income while a long term impact is on bank’ net

So, there aretwo common perspectives for the assessment of IRR:

Earning Pespective :- this is a traditional approach obtained by neasuring changes in

the Net Interest Income.

Economic Value Perspective :- it reflects the impact of fluctuations in the interest

rate on economic value of the bank.

• Credit Risk Management :- credit risk emanates from a bank’s dealing with
individual’s, corpoprate, financial institutions or a sovereign. Credit risk arises from
the potential that an obligor is either unwilling to performon an obligation or it’s
ability to perform such obligation is impaired resulting in economic loss to the bank.
For most banks loans are the obvious source of credit risk. It is overall responsibility
of bank’s board to bank’s credit risk strategies and significant policies relating credit

• Asset - Liability Management :- ALM is a comprehensive and dynamic framework

for measuring, monitoring, and managing the market risk of a bank. It is the
management of structure of balance sheet in such a way that the net earning from
interest is maximized within the overall risk – preference of the banks.

Credit Rating is an act of assigning values to credit instruments by assessing the solvency
i.e. , the ability of the borrower to repay debt. It is an assessment of the credit quality and
investment quality of a debt instrument. It provides the investors, a system of gradation to
identify the ability of the issuers to make timely payment of interest and principal repayment
of a particular debt security. The lower the rating , the higher is the risk of investors involved.

Credit rating is an opinion on the future ability and legal obligation of the issuer to make
timely payments of principal and interest on a specific fixed income security.

Credit rating is an opinion and not the guarantee, credit rating is made on the basis of known
facts and figures and estimated creditworthiness of the issuers.

A rating is neither a general purpose evaluation of the issuer , nor an overall assessment of
the credit risk involved in all the debts contracted or to be contracted by such entity. It is not a
recommendation to buy , or sell a security. It does not create any type of relationship between
the agency and the user. It is the instrument which is rated not the issuer.


i) The issuer's ability to pay,

ii) ' The strength of the security owner's claim on the issue, and

iii) The economic significance of the industry and market place

of the issuer.
Explanation :

Ratio analysis is used to analyse the present and future earning power of the issuing
corporation and to get insight into the strengths and weaknesses of the firm. Bond rating
agencies have suggested guidelines about what value each ratio should have within a
particular quality rating. Different ratios are favoured by rating agencies. For any given set of
ratios, different values are appropriate for each industry. Moreover, the values of every firm's
ratios vary in a cyclical fashion through the ups and downs of the business cycle.

To assess the strength of security owner's claim, the protective provisions in the indenture
(legal instrument specifying bond owners' rights), designed to ensure the safety of
bondholder's investment, and are considered in detail.

The factors considered in regard to the economic significance and size of issuer includes:
nature of industry 'in which issuer is, operating (specifically issues like position in the
economy, life cycle of the industry, labour situation, sup- p- l -y

factors, volatility, major vulnerabilities, etc.), and the competition faced by the issuer (market
share, technological leadership, production efficiency, financial structure, etc.)


• INVESTORS: Rating safeguards against bankruptcy through recognition of risk. It

gives an idea of the risk involved in the investment. It gives a clue to the credibility of
the issuer company. Rating symbols give information on the quality of instrument in a
simpler way that can be understood by lay investor and help him in taking decision on
investment without the help from broker. Both individuals and institutions can draw
up their credit risk policies and assess the adequacy or otherwise of the risk premium
offered by the market on the basis of credit ratings.

• ISSUERS:A company whose instruments are highly rated has the opportunity to have
a wider access to capital, at lower cost of borrowing. Rating also facilitates the best
pricing and timing of issues and provides financing flexibility. Companies with rated
instruments can use the rating as a marketing tool to create a better image in dealing
with its customers, lenders and creditors. Ratings encourage the companies to come
out with more disclosures about their accounting systems, financial reporting and
management pattern. It also makes it possible for some category of investors who
require mandated rating from reputed rating agencies to make investments.

• FINANCIAL INTERMEDIARIES: Financial intermediaries like banks, merchant

bankers, and investment advisers find rating as a very useful input in the decisions
relating to lending and investments. For instance, kith high credit rating, the brokers
can convince their clients to select a particular investment proposal more easily
thereby savings on time, cost and manpower ill convincing their clients.


 Main sources of information to the credit rating agencies are:

-Annual interim reports available on each issuer.

-Prospectus, letter of offer etc. of particular securities.

-Industry, sectoral and economic data from industry groups.

-Reports and data from government agencies.

-Primary data collection

 To analyses and come to a conclusion on the appropriate rating.

 To monitor the credit quality of the rated issuer or security over time ,declining on the
timely changes in the rating as company fundamentals changes.

 To keep the market & investors informed.


Rating is a search for long-term fundamentals and the probabilities for changes in the
fundamentals. Each agency's rating process usually includes fundamental analysis of public
and private issuer-specific data, 'industry analysis, and presentations by the issuer's senior
executives, statistical classification models, and judgement. Typically, the rating agency is
privy to the issuer's short and long-range plans and budgets. The analytical framework
followed for rating methodology is divided into two interdependent segments.

The first segment deals with operational characteristics and the second one with the financial
characteristics. Besides, quantitative and objective factors; qualitative aspects, like
assessment of management capabilities play a very important role in arriving at the rating for
an instrument. The relative importance of qualitative and quantitative components of the
analysis varies with the type of issuer.

Key areas considered in a rating include the following:

i) Business Risk : To ascertain business risk, the rating agency considers Industry's
characteristics, performance and outlook, operating position (capacity, market
share, distribution system, marketing network, etc.), technological aspects,
business cycles, size and capital intensity.

ii) Financial Risk : To assess financial risk, the rating agency takes into account various
aspects of its Financial Management (e.g. capital structure, liquidity position,
financial flexibility and cash flow adequacy, profitability, leverage, interest
coverage), projections with particular emphasis on the components of cash flow
and claims thereon, accounting policies and practices with particular reference to
practices of providing depreciation, income recognition, inventory valuation, off-
balance sheet claims and liabilities, amortization of intangible assets, foreign
currency transactions, etc.

iii) Management Evaluation: Management evaluation includes consideration of the

background and history of the issuer, corporate strategy and philosophy,
organisational structure, quality of management and management capabilities
under stress, personnel policies etc.

credit ratings are provided to maufacturing companies ,banks,non-banking financial

companies,financial insititutions, municipal bodies & companies in the infrasturute sector &

Subprime is a big lesson to learn ,why is is always suggested to check credit rating before
investing or borrowing.for that matter,we are having major credit rating agencies like
ICRA,CARE,CRISIL,FITCH RATING'S etc.after global recession has started ,it is not just
the world's biggest financial market(the U.S) the credit ratings are under watch.Now,RBI has
asked CRA'sto clearly diffenrentiate the ratings for structured products,improve their
disclosure of rating methodology & assess the qualityof information provided by orginators
,arrangers & issuers of structured product.

REGULATORY FRAMEWORK - In India, credit rating agencies are registerd with &
regulated by sebi.Under the SEBI Act,1992,it has issued SEBI(credit rating agencies)
regulations ,1999.These ragulations were provided for general obligation ,restrictions on
ratings,procedure of inspections & investigations.

The guidelines issued by SEBI provide that no company shall make a public issue or right
issue of debt instrument unless credit rating of not less than investment grade is obtained
from not less than two registered credit ratings agencies.


A. CRISIL:- it was set up in 1987,jointly icici ltd.,uti,lic,gic,hdfc ltd.However in

2005,standard & poor's inc. of U.S acquired 51% eq. sh. in CRISIL & since then ut us
working as former.CRISIL provides 4 categories of financial services:-

1.credit rating service

2. advisory services

3.credit first rating & evaluation services,&

4.training services
CRISIL has also launched Crisil -500 eq. index & Crisil Mid cap -200 Eq index to provide
information to investors in respect of share prices of different companies listed at BSE.

B. ICRA(Investment information & credit rating agency of india)- it was promoted in 1991
by IFCI ltd. together with UTI,LIC,GIC,HDFC,ILFS & commmercial banks. it was enterd
into MOU with Moody's Inestors srevices & provides

1)credit evaluation

2)research & consultancy services to banks ,instituions

3) risk management software

C. CARE(credit analysis & research ltd.)it was set up in 1993 by idbi in collabration with
other financial instituions ,banks & finance comapnies out of several speacialised
services,Care loan rating,rating of collective invetment schemes like plantation etc. are

D. Fitch ratings:- it is a 100% subsidiary of an international rating agency.it provides credit

rating of loan securitisation programmes also.

SOVERIGN RATING- A soverign rating is the credit rating of a soverign entity

i.e,country.the soverign credit rating indicates the risk level of the investing envorinment of a
country & is used by invetors to invest abroad ,It takes political risk & economic risk into

A soverign credit rating indicates the risk level of invetsing in debts issued by that particular
country.so,the rating also determines the country's ability to borrow money & the level of
interes it needs to pay.the stronger a countries credit rating ,the easier it is to attract
investment capital & the lower funding cost.

 CREDIT GAP is defined as the difference between the desired and actual level of debt.It
can be defined as the difference in the amount of money that is desired or required by the
company as finance and that is available to them.It occurs when banks and financial
institution are not able to meet the need of particular groups like small business firms,
risky firms etc.

 People from rural areas and small business experience the credit crunch. Small scale
business is most affected by the credit gap. Credit gap varies across the various industries,
manufacturing firms facing larger gap than wholesale or service industry. credit gaps are
based on firm size, knowledge orientation, risk factor,growth,gender etc.

 The varying nature of credit gap even amongst small business is due to:-

1. distinct operating cycle

2. fixed asset to net worth ra

Small scale industries play a crucial role in the economic development of a nation along with
the industrialisation. This is because they provide immediate large scale employment, need
shorter gestation period, need low investment etc.

 The estimated credit gap faced by small scale unit is 20 %( approx.) i.e. on an average
they would require 20% more debt.

 A better understanding of credit gap facing small scale business is important for
targeting business that are more vulnerable to changing credit conditions.

 For measuring credit gap we need to have information about two things:-
1. Identify all those borrowers who did not apply fearing the denial of application

2. Identify all those firms that were unable to acquire the amount they applied for.


1. No credible mechanism to convey the private information about the business by

owners to lenders i.e. INFORMATION ASSYMETRY in which lenders are unable to
identify and charge high rate of interest from high risk borrowers.

2. unavailability of adequate amount of assets that can be mortgaged as guarantee as

small scale business are characterised by limited access to finance

3. lack of funds with the banks and financial institutions


1. Collateral and guarantees can be viewed as powerful tool that allows banks to offer
credit on favourable terms as it reduces the cost and banks are in position to value the
security assets at lower costs.

2. Banks also use restrictive loans to solve this problem and also it prevents borrowers
from indulging in risk shifting behaviour.

3. Loan maturity is another tool. a sequence of short term loans can better solve this
problem and moreover small scale units have very minimal access to long term funds.

4. Another effective mechanism is RELATIONSHIP LENDING, this is a process

through which banks by maintaining continuous gather private information over
several years i.e. relationship building with the lenders.

5. Increasing liquidity i.e. money supply also helps to overcome this problem.

6. Somehow signalling the credit worthiness can help banks in judging the true position
of the business and better solve this problem.
Maximum Permissible Banking Finance (MPBF)

As we know that granting loans and advances is one of the prime function of the banks. A bank
grants, basically, two types of loans to the business organizations or the business units. One is the
Term Loans for the fixed assets and the other is for the working capital and here, the MPBF comes
into role when we have to decide on the limit of working capital which a bank can grant.

There are 3 main methods to assess the working capital requirement of the borrowers:

1. Turnover Method

2. Cash Budget Route Method


Methods to
assess the
Turnover Cash Budget Permissible
Method Route Method Banking


This method applies for the credit needs upto Rs.2 crores, particularly for the SSI, Small Businesses
& traders. Bank will provide upto 20% of projected turnover of company. However, sanction will be
subject to company putting up 5% of the value of the projected sales as investment in current assets.


This method applies for the credit needs of above Rs.10 crore, particularly for the large companies.
Here, the funds will be provided by bank up to 75% of cash deficit, while 25% deficit will be
contributed by the company.


This method was laid down by Reserve Bank of India (RBI) as the constraints based on the
recommendations of the Tandon Committee. This method applies for the corporates wanting credit
upto Rs.10 crore. But it should be kept in mind that this method will not be available for the
corporates with limits above Rs.10 crore.

As per the recommendations of Tandon Committee,

 The corporates should be discouraged from accumulating too much of stocks of current assets
and should move towards very lean inventories and receivables.
 The committee even suggested the maximum levels of Raw material, Stock-in-process and
Finished Goods which a corporate operating in an industry should be allowed to accumulate.
These levels were termed as inventory and receivable norms.
 Depending on the size of these current assets (working capital needs) of the corporates
could be met by one of the following methods:

• First Method of Lending:

Banks can work out the working capital gap, i.e. total current assets less current liabilities
other than bank borrowings (called Maximum Permissible Banking Finance or MPBF) and
finance a maximum of 75% of the gap; the balance to come out of long-term funds,i.e.,
owned funds and term borrowings. This approach was considered suitable only for very small
borrowers i.e., where the requirements of credit were less than Rs.10 lakhs.

• Second Method of Lending:

Under this method, it was thought that the borrower should provide for a minimum of 25% of
total current assets out of long-term funds i.e., owned funds plus term borrowings. A certain
level of credit for purchases and other current liabilities will be available to fund the build-up
of current assets and the bank will provide the balance Maximum Permissible Banking
Finance (MPBF). Consequently, total current liabilities inclusive of bank borrowings could
not exceed 75% of current assets. RBI stipulated that the working capital needs of all
borrowers enjoying fund-based credit facilities of more than Rs.10 lakhs should be appraised
(calculated) under this method.
• Third Method of Lending:
Under this method, the borrower’s contribution from long-term funds will be to the extent of
the entire CORE CURRENT ASSETS, which has been defined by the Study Group as
representing the absolute minimum level of raw materials, process stock, finished goods and
stores which are in the pipeline to ensure continuity of production and a minimum of 25% of
the balance current assets should be financed out of the long-term funds plus term

Thus, for determining MPBF, methods suggested were-

METHOD I: 0.75 (CA – CL)

METHOD II: 0.75 (CA) – CL

METHOD III: 0.75 (CA – CCA) – CL

Where, CA = Current Assets corresponding to suggested norms or past levels if lower

CL = Current liabilities excluding bank lending

CCA = CORE Current Assets i.e. Permanent Current Assets

Consortium Lending
Consortium Lending or Syndicated loan facility, defined by a single loan agreement,
in which several or many banks participate i.e., several banks or financial institutions
associate to provide loan to a single person/group. This approach to lending was introduced
by the RBI in 1974. It required that more than one bank would finance a single borrower
requiring large credit limit.

Unlike bilateral loan, which only involves one borrower & a one lender consortium
lending involves one borrower & a group of lenders. When Consortium Approach was
introduced in 1974, banks were required not to invest more than 1.5% of their deposits or
Rs.100 crore in one account, whichever was lower. Since March 1989, banks were required
not to lend more than 25% of their capital to an individual borrower, and not more than 50%
to a group of borrowers. Similarly, earlier not more than five banks were to participate in a
loan account up to Rs.50 crore. From October 1988, this restriction of Rs.50 crore and limit
of 5 members had been removed but banks were advised to limit their number in a formal
consortium arrangement to around 10.

Reasons for Consortium Lending

The following are the reasons for consortium lending arrangements:

• Consortium Lending is opted for large business loans. This is because if the bank has
only one large business loan, and if that business happens to be one of the party that
defaults. Then the bank loses all its money. For this reason, it is in the best interest of
tall banks to split, their large loans with each other, so each bank gets a representative
sample in their loan portfolios and the risk gets diversified. So, Consortium Lending
avoids large or surprising losses and instead usually provides small and more
predictable losses.

• The borrowing requirements of businesses are sometimes beyond the funding and
credit risk capacity of single lenders. As a result, some loans are arranged as
consortium with the funds jointly provided by two or more lenders. So when a
borrower wants to raise a relatively large amount of money quickly and conveniently
Consortium Lending is opted for.

• When a single bank cannot meet all requirements of the borrower and the borrower
does not want to deal with a large number of lenders separately so lending banks
provide an arrangement in which they join hands and one of them i.e. the agent deals
with hem.

Participants in Consortium Lending

Arranger / Lead Manager

Arranger or Lead Manager includes the bank that is awarded the mandate by the
prospective borrower and is responsible for placing the syndicated loan with other banks and
ensuring that the syndication is fully subscribed.

Lead managers are responsible for structuring the loan facility, including the pricing
and terms and conditions. Most of the banks in this lead group would be involved in funding
the loan and, in larger deals, also responsible for marketing the loan to other banks.
Underwriting Bank

The underwriting bank commits to supply the funds to the borrower if necessary from
its own resources if the loan is not fully subscribed. Underwriting bank may be the arranging
bank or another bank. Not all syndicated loans are fully underwritten.

Underwriting banks may bear the risk that the loan may not be fully subscribed.

Participating Bank

Participating bank participates in the syndication by lending a portion of the total

amount required. If charges interest and participation fee. The risks borne by the bank is
borrowers credit risk.

Facility Manager / Agent

Agent takes care of the administrative arrangements over the term of the loan (e.g.
disbursements, repayments, compliance) on behalf of the bank. Agent may be the
arranging /a underwriting bank. In case of larger syndications co-arranger and co-manager
may be used.

Benefits of Consortium Lending

 Benefits to Borrower

 The borrower has to deal with a single bank only.

 It is quicker and simpler than other ways of raising capital (e.g., issue of bonds
and equity).

 Benefits to the Lead Banks

 It enhances bank’s reputation and relationship with clients.

 It is a good lending arrangement in which fees can be earned without

commitment of capital alone.

 Benefits to the Participating Banks

 It provides access to lending opportunities with low marketing costs.

 It provides opportunities to participate in future syndications.

 Participant banks do not find themselves at a disadvantage vis-à-vis a

dominant bank or one with high leverage over the client.

 In case the borrower runs into difficulties, participating banks have equal

Limitations of Consortium Lending

 Banks usually do not adhere to the RBI Guidelines.

 No uniform approach to evaluate credit proposals.

 Lead bank may overshadow or dominate the participating banks.


There are three stages of consortium lending

1. Pre- mandate phase

2. Placing the loans

3. Post-closure phase

Pre- mandate phase

In this phase the prospective borrower either approaches a single bank or multiple banks for
competitive borrowing.

The single bank further does the following jobs for the borrower: -

 Identification of credit needs of the borrower

 Designing an appropriate loan structure

 Preparing a comprehensive and persuasive proposal for the purpose of easy and quick
access to syndication

Placing of the loan

Under this phase, the leading bank sells the loan in the market for which it prepares the
following: -

 An information bulletin

 A term sheet

 Legal documentation

Then, the bank approaches the prospective participating banks by selecting and inviting them.
Negotiation with the participating banks is done in case they raise a particular issue
concerned. This phase ends with signing of the multiple arrangements of the banks and
resulting in the formation of consortium.

Post-closure phase

In this phase the agent bank conducts the day-to-day transactions of the consortium borrower.


Meaning of consortium pricing

It is the cost a prospective borrower has to pay in the case of a consortium lending (multiple
banking arrangement) in the terms of time and money.


1. Monetary

2. Non- monetary

Monetary pricing

1. Interest that a borrower has to pay to its lending banks based on the proportion of each
one of them in the amount given as credit is the main cost a borrower has to pay.

2. Fees to the leading bank for its function of syndication performed by it on the behalf
of the borrower known as PRINCIPIUM.

3. Fees to the underwriting bank for the risk it undertook in case the required amount of
syndication is not achieved.
4. Fees to the participating bank

 Participating fees is given to the participating bank for the simple reason that it agreed
to be a part of the consortium.

 Commitment fees is given to the participating banks for the simple reason that when it
sanctions loan to a consortium borrower, its cash gets blocked whether or not it is
being drawn and used by the borrower or not. This fees is given as compensation for
the opportunity cost in the form of interest a participating bank bears when their
regulatory capital is drawn.

 Utilization fee is given to the participating bank as the borrower utilizes the funds of
the bank. In this case the rate of interest is low.

5. An annual fee is given to the agent bank that gives administrative services to the
borrower in the post-closure phase.

Non-monetary conditions or covenants

These are the undertakings by the consortium borrower that are restrictions or qualitative
conditions as per the loan agreement such as use of sale proceeds of the assets, limit of
additional financing, etc.


Shetty committee was formed in August 1993 to introduce far reaching reforms in

Consortium lending. These reforms were as follows: -

a. The amount of borrowings for which it becomes obligatory to form a consortium was
increased from Rs. 5 crores to Rs. 50 crores. Now, the amount has no limit.

b. A bank can voluntarily form a consortium for its highly rated corporate borrower
subject to the condition that the borrower has at least a working capital base of Rs. 50

c. Fixing up of the maximum time frame within which the lending banks have to
respond to the applicant borrower as stipulated in the loan agreement.
d. There were certain changes in the set of documents required by the participating

e. After two years of formation of a consortium a new bank can be a part of a

consortium and an existing bank can quit but subject to the consensus of the whole

f. The maximum number of participating bank in a consortium was earlier 25 that is

increased to 50.
Theories of loan pricing

 The classical theory

 Keynsian theory

 The loanable fund theory

Determinants of loan pricing

 Default risk

 Call risk

 Tax status

 Marketability & liquidity

1. Based on matching the competition.

Indexing loan rates to national or local indexes.


 Simple method

 Loan pricing practices are commensurate with the market.


 Loan rates charged are not sufficient to cover institution expenses ,risks and
profitability needs.

2. Based on targeted net interest rates spread


 loan rates are set at a level to generate desired level of earnings.


 Institution may be pricing its loan out of the market.

 does not works well for risk based or differential pricing of individual loans.

3. Based on risk adjusted return on capital (RAROC)

Allocate capital to a loan based on the risks in the loan. Calculate the revenues
associated with a loan, including the interest income and any fee-based income. These
revenues need to be spread over the life of the loan, while taking into account the
amortization characteristics of the balance

Loan pricing in India to evolve on International standards

• RBI introduced the benchmark prime lending rate system in November 2003 to bring
transparency in the system of lending.
• Reserve Bank of India has appointed a working group for reviewing the existing
system of loan pricing.
• The step has been taken in view of the increased sub-benchmark prime lendings by
the banks.
On Oct 1, 2009, The Reserve Bank of India (RBI) committee on reviewing the BPLR had
recommended :-

 that BPLR should be replaced by Base Rate.

 there should not be separate benchmark rates for retail and corporate sector.

Factors affecting loan pricing


LTV = Loan amount

Purchase price

Purchase Price = Rs 15,00,000

Down Payment = Rs 2,00,000

Loan Amount = Rs 13,00,000

(higher the LTV, higher the interest rate on loan)




DTI higher than 36% is not considered to be good

Some tips to obtain a loan at a lower price

 Lowering the LTV ratio by putting more down payments.

 Finding a co signer with additional income to support the loan.

 Paying off other debts to lower DTI ratio.

 Clearing out inaccurate reports on your credit record

Loan repayment methods

 Steady principal reduction method

Annual instalment= fixed equal principal amt. + Interest on o/s principal


Fixed equal principal amt.= Cost of asset – down payment

No. Of instalments
Interest = Principal O/S At The End Of Previous Year * Interest Rate

 Steady Payment Method

Annual installment amt. = Amount borrowed

Relevant annuity factor

Annual principal amt. = annual installment – annual interest

Interest is calculated on the balance of principal amt. o/s at the beginning of each year.

 Balloon payment method

Annual Installment Amt. = Annual Principal Amt + Interest on O/S Principal

Annual Principal Amt. = Annual Installment – Annual Interest

Interest is calculated on the balance of principal amt. o/s at the beginning of each year.

(Interest rate is high)


 Can there be an ideal prime lending rate?

 Components of prime lending rate:-

i. Funding cost

ii. Operating cost

iii. Risk premium

iv. Profit margin


The New Economic Policy of structural adjustments and stabilization programme was given a
big thrust in India in June 1991. Immediately after the announcement of NEP, the
government appointed a high level committee on financial system, “to examine all aspects of
structure, organization, functions, and procedures of the financial system” under the
chairmanship of Mr. M Narsimham, a former governor of RBI. The committee was primarily
interested in improving the financial health of the public sector banks and development
financial institutions, so as to make them viable and efficient to meet fully the emerging
needs of the real economy.

India witnessed a phenomenal expansion in the geographical coverage and functional spread
of the banking and financial system since bank nationalization in 1969. However despite
impressive quantitative achievements in resource mobilization and in extending credit reach,
several distortions crept into the banking and financial system, as a result of which the
productivity and efficiency of the system suffered, portfolio quality deteriorated, and
profitability declined.


The banking system of India was suffering from the following problems at that time:


The system of directed investment was a result of increasing SLR and CRR. A higher SLR
(38.5%) forced commercial banks to maintain a larger proportion of their funds in
government securities and reducing their ability to grant loans and advances to business and
industry. It adversely affected profitability of the banks because the rate of interest on
government securities was less than market related rate of interest.

The higher CRR (15 %) also depressed income of banks because the interest paid by RBI was
below the opportunity cost of funds of banks.


A major objective of bank nationalization in 1969 was to extend the reach of bank credit to
geographically unbanked regions and agriculture and other neglected sectors.

The government achieved this system at the cost of decline in quality of loans, inadequate
attention to qualitative aspects of lending, growth of over dues, and consequent reduction in


According to the Narsimham Committee, the most serious damage to the public sector banks
was the political and administrative interference in credit decision making.

For example, loan melas organized by Congress party leaders in 1970s and 1980s to direct
bank credit to their supporters in rural and urban areas was against the principle of sound
banking. Also Central and State directed banks to continue to extend credit to the sick
industrial units, often against their better commercial judgement.


The government of India stipulated that bank lending to the priority sector and IRDP
(Integrated Rural Development Programmes) lending would be at concessional rate of
interest, which was like a subsidy on such loans. This cut the profits of banks. To make this
loss, banks were forced to charge very high interest on borrowers from industry and trade.

From the expenditure side, public sector banks were saddled with mounting expenditure on
account of the following reasons-

a. Phenomenal increase in branch banking without any potential need or viability.

b. Lines of command and control made central office supervision, internal inspection
and audit weak.

c. Rapid growth in number of staff and accelerated promotions led to deterioration in

quality of manpower and over manning at all levels.

d. Trade Unions contributed increasingly to restrictive practices regarding promotions,

transfers, discipline and work culture, mechanization and computerization. The
consequences were inefficient customer service and declining labour productivity.

It was under these circumstances that the government of India appointed the Narsimham
Committee. The committee was appointed in June 1991 and it submitted its report in



The basic approach of the committee was that “greater market orientation would strengthen
the financial system and thus improves its efficiency: and solvency, health and efficiency of
the institutions should be central to the effective financial reform”.


The Narsimham Committee’s recommendations were based on the fundamental assumption

that the resources of the banks come from the general public and were held in banks in trust
and thus they were to be deployed for the maximum benefit of the depositors. So the
government had no business to endanger the solvency, health, and efficiency of nationalized
banks. Also government has no right to hold banks’ funds at low rate of interest and use them
for financing its consumption expenditure.


The recommendations of the committee were based on the following three considerations-

i. Ensuring a degree of operational flexibility.

ii. Internal autonomy for public sector banks in their decision-making process.

iii. Greater degree of professionalism in banking operations.


Major recommendations of the Narsimham Committee were:


The Committee gave two important recommendations as regards SLR and CRR.


The Committee was of the view that the government should immediately give up the practice
of using SLR as a major instrument of mobilizing funds for government and recommended
that it should reduce SLR from 38.5% to 25%. This would leave more funds with banks for
allocation to agriculture, industry and trade.


The committee recommended that RBI should rely upon open market operations increasingly
and reduce its dependence on CRR and release the amount for more productive and
remunerative purposes.


The committee recommended to phase out the directed credit programmes because
agriculture and small industry were in mature stage and did not require any special support.
They also argued that the directed credit programmes should not be regular but a case of
temporary extraordinary support to certain weaker sections of the economy. They proposed
that the priority sector should only include weakest sections of rural community like marginal
farmers, rural artisans and cottage industries etc. and credit programme for this ‘redefined’
priority sector should be fixed at 10% of the total bank credit and the system should be
reviewed after a period of three years.


The committee recommended that the level and structure of interest rates in the country
should be broadly determined by the market forces. All controls and regulations on interest
rates on lending and deposit rates of banks and financial institutions should be removed. They
also recommended that RBI should be the sole authority to simplify the structure of interest


The committee proposed a substantial reduction in the no. of public sector banks through
mergers and acquisitions in order to bring about greater efficiency in banking operations. The
committee proposed that the system of opening new branches to spread banking should be
discontinued and banks should have the freedom to open branches based on profitability

The committee also wanted the government to declare that there would be no more
nationalization of banks and allow foreign banks to open their branches in India.


Some of the other recommendations made by the Narsimham Committee were as follows


A novel recommendation of the committee was establishment of a new financial institution

called Assets Reconstruction Fund (ARF) which would take over from banks a portion of
their sub-standard, doubtful and loss assets, known as non-performing assets at discount and
follow up recovery from primary borrowers. This would help the banks to recycle the funds,
through this process, into more productive uses.


The committee recommended that the present system of dual control over the banking system
between RBI and Banking Division of Ministry of Finance should end immediately and RBI
should be the primary agency for regulations of the banking system.


The committee recommended that the public sector banks should be free and autonomous.
Every bank should go for a radical change in work technology and culture, so as to become
competitive internally and to be in step with wide-ranging innovations taking place abroad.


The recommendations of the Narsimham committee were revolutionary in many respects and
were naturally opposed by bank unions and the leftist political parties.

Despite stiff opposition, the Government of India accepted the entire major recommendations
of Narsimham committee and started implementing them straight away:-


SLR was reduced from 38.5% to 25%.

CRR of 10% was abolished, but RBI could not reduce CRR immediately. When the
conditions eased and money growth started slowing down in 1995-96, RBI reduced CRR
gradually from 15% to 5.5% in 2001 so as to release funds locked up with RBI for lending to
industrial and other sectors which were starved of bank credit.


Interest rate slabs were reduced from 20 to 2 by 1994-95. The purpose of deregulation of
interest rates was to stimulate healthy competition among banks to encourage their
operational efficiency. It would also help banks better adjust their lending rates to the track
record and risk perception with regard to their customers.

Scheduled banks were free to set interest rates on their deposits subject to minimum floor
rates and maximum ceiling rates.


Prudential norms have been started by RBI as part of the reformative process. The purpose of
prudential system of recognition of income, classification of assets and provisioning of bad
debts was to ensure that the books of commercial banks reflect their financial position more
accurately and in accordance with internationally accepted accounting practices. This help in
more effective supervision of banks.

Prudential norms required banks to make 100 percent provision for all non-performing assets
(NPAs). Banks had to make at least 30 percent provision against doubtful and bad debts
during 1992-93 and the balance 70 percent in 1993-94.


Capital adequacy norms were fixed at 8 percent by RBI in April 1992 and banks had to
comply with them over a three year period. By end March 1996, all public sector banks had
attained capital to risk weighted assets ratio of 8 percent.
The prudential guidelines and the new capital adequacy norms expected scheduled banks to
make large provisions amounting to over Rs. 14000 crores or bad and doubtful advances in
their portfolio. As the resulting losses would erode the already inadequate capital of the
banks, the viability and financial health of the banking system was sought to be protected by
a capital contribution of Rs. 5700 crores by the Union Government in the budget for 1993-94
and another Rs. 5600 crores in the budget for 1994-95 for recapitalization of the less
profitable nationalized banks.


Banks which attained capital adequacy norms by April 1992 can set up new branches without
the prior approval of RBI by rationalizing their existing branch network by relocating
branches, opening of specialized branches, setting up of controlling offices or administrative
units etc.

Besides these major actions, RBI also announced guidelines for the setting up of private
banks as public limited companies. The guidelines stipulated that the banks in the private
sector should be financially viable and avoid shortcomings such as unfair concentration of
credit, cross holding with industrial groups etc.

As a result of all these measures, the commercial banking system in the country has been
Nonperforming Asset
A debt obligation where the borrower has not paid any previously agreed upon interest and
principal repayments to the designated lender for an extended period of time. The
nonperforming asset is therefore not yielding any income to the lender in the form of
principal and interest payments. Banks usually classify nonperforming assets as any
commercial loans which are more than 90 days overdue and any consumer loans which are
more than 180 days overdue. More generally, an asset which is not producing income

A Non performing asset (NPA) is an advance or loan where;

 interest and /or installment of principal remain overdue for a period of more than 90
days in respect of a Term Loan,

 the account remains 'out of order' for a period of more than 90 days, in respect of an
overdraft/ cash Credit (OD/CC),

 the bill remains overdue for a period of more than 90 days in the case of bills
purchased and discounted,

 interest and/ or installment of principal remains overdue for two harvest seasons but
for a period not exceeding two half years in the case of an advance granted for
agricultural purpose.

 Any amount to be received remains overdue for a period of more than 90 days in
respect of other accounts

Thus, an asset , including a leased asset, becomes Non-Performing when it ceases to

generate income from the Bank.

Out of order

An account should be treated as out of order if the outstanding balance remains continuously
in excess of sanctioned limit /drawing power. in case where the out standing balance in the
principal operating account is less than the sanctioned amount /drawing power, but there are
no credits continuously for six months as on the date of balance sheet or credit are not enough
to cover the interest debited during the same period ,these account should be treated as ‘out of


Any amount due to the bank under any credit facility is ‘overdue’ if it is not paid on due date
fixed by the bank.

The Securitization and Reconstruction of Financial Assets and Enforcement of Security

Interest (SARFAESI) Act, 2002 defined non-performing assets (NPAs) as “an asset or
account of a borrower, which has been classified by a bank or financial institution as sub-
standard, doubtful, or loss assets in accordance with the direction and guidelines relating to
asset classification issued by the RBI”


Sub-standard Assets

i. With effect from March 31, 2005 an asset would be classified as sub-standard if it remained
NPA for a period less than or equal to 12 months. In such cases, the current net worth of the
borrowers/ guarantors or the current market value of the security charged is not enough to
ensure recovery of the dues to the banks in full. In other words, such assets will have well
defined credit weaknesses that jeopardize the liquidation of the debt and are characterized by
the distinct possibility that the banks will sustain some loss, if deficiencies are not corrected.

ii. An asset where the terms of the loan agreement regarding interest and principal have been
re-negotiated or rescheduled after commencement of production, should be classified as sub-
standard and should remain in such category for at least 12 months of satisfactory
performance under the re-negotiated or rescheduled terms. In other words, the classification
of an asset should not be upgraded merely as a result of rescheduling, unless there is
satisfactory compliance of this condition.

Doubtful Assets

With effect from March 31, 2005, an asset is required to be classified as doubtful, if it has
remained NPA for more than 12 months. For Tier I banks, the 12-month period of
classification of a substandard asset in doubtful category will be effective from April 1, 2009.
As in the case of sub-standard assets, rescheduling does not entitle the bank to upgrade the
quality of an advance automatically.

A loan classified as doubtful has all the weaknesses inherent as that classified as sub-
standard, with the added characteristic that the weaknesses make collection or liquidation in
full, on the basis of currently known facts, conditions and values, highly questionable and

Consequent to change in asset classification norms w.e.f. March 31, 2005 banks are permitted
to phase the consequent additional provisioning over a five year period commencing from the
year ended March 31, 2005, with a minimum of 10 % of the required provision in each of the
first two years and the balance in equal installments over the subsequent three years.

Loss Assets

A loss asset is one where loss has been identified by the bank or internal or external auditors
or by the Co-operation Department or by the Reserve Bank of India inspection but the
amount has not been written off, wholly or partly. In other words, such an asset is considered
un-collectible and of such little value that its continuance as a bankable asset is not warranted
although there may be some salvage or recovery value.


 Standard Assets – general provision of a minimum of 0.25%

 Substandard Assets – 10% on total Secured balance, 20% on unsecured exposures

identified as sub-standard.

 Doubtful Assets – 100% to the extent of unsecured balance, not covered by realizable
value of security. In case of secured portion, provision may be made in the range of
20% to 100% depending on the period of asset remaining doubtful.

 Loss Assets – 100% of the outstanding

Effect of NPAs on Banks and FIs

1. Reduce the earning capacity of assets and badly affect the Return on Assets (ROA) of
the banks and FIs. Loans extended by banks and FIs are their assets. If these loans
increasingly become NPAs then it would obviously lead to reduced earning and lower

2. Lead to higher provisioning requirement on mounting NPAs and so adversely affect

capital adequacy and profitability. RBI guidelines state the provisions to be
maintained by banks and FIs on different categories of NPAs. The provisions have an
adverse effect on the profit and loss account of lenders reducing their profitability.
Also, provisioning affects the capital adequacy ratio adversely.

3. Cost of capital increases due to NPAs and reduce the Economic Value Added (EVA =
Net Operating Profit after Tax – Cost of Capital) of the company. Rising NPAs
indicate rising risk which will lead to an increase in the cost of capital and thus
adversely affect the EVA of lenders.

4. NPAs cause decline in the value of shares sometimes even below their book value in
the capital market. This can happen when balance sheets of companies reflect high
degree of NPAs which reduce investor confidence.

5. They affect the market competitiveness of lenders. A high degree of NPAs would
mean increased cost for the bank or FI in comparison to its competitor. High NPAs
reduce the flexibility of banks and FIs and thus reduce their market competitiveness.

6. Cause reduction in availability of fund for further credit expansion due to the
unproductiveness of the existing portfolio. Higher provisioning and capital adequacy
requirements will reduce the amount of funds available to be employed

for extending loans. Funds remain stuck in existing NPAs which do not generate

any earnings for the lenders.

7. NPAs affect the risk taking ability of the banks. Due to presence of NPAs on balance
sheet, banks and FIs think twice before taking any risk which restricts their earning
capacity too. They are skeptical of following new ideas which might generate more
profits due to the fear of adding more to the NPAs.

8. They affect the credibility of the bank making it difficult for the bank to raise fresh
capital from the market in case of future financial needs. High NPAs reduce
credibility of banks and FIs and so investors/depositors will not show confidence in
extending their money to these banks or FIs.

9. Increased regulations by RBI. The RBI is responsible for the smooth functioning of
the financial sector of the country. If the level of NPAs rises, then it becomes a cause
of concern for the central bank. So, it might make the existing regulations more
stringent or introduce new regulations. All this will reduce the flexibility of operations
for the banks or FIs.

Reasons for high NPAs in India

 Rising interest rates and increased loan growth

The interest rates remained at high levels throughout the 1980s upto 1990. The PLR of SBI
peaked at 19% in1992-94. Subsequently the PLR declined hitting a low at 10.25% (SBI) in
2003-04. The PLR rose again and was at 12.75% (SBI) in 2006-07.

High PLR led to loans on floating rates to become very expensive. So, there were many
defaults due to inability of borrowers to repay at such high rate of interests.

The total amount of advances extended by banks and financial institutions grew many folds
to meet the increasing capital demand in the country. Hence, NPAs rose due to this phase of
loan growth in the country.

 Priority lending

Another reason of mounting NPAs in India was the policy of priority lending to be followed
by banks and FIs in advancing loans. The RBI issued guidelines to be observed by banks and
FIs in order to meet the priority lending targets set by it. The priority sector consisted of
agriculture, small scale industries, housing and advances to weaker sections of the society etc.

The banks and FIs were used as instruments of social and economic change rather than as
profit making enterprises. It has been observed that in order to meet the targets of priority
lending in India banks have suffered from NPAs.

 Wilful defaults

Another major reason for the high levels of NPAs in the country was wilful defaults by
borrowers. Absence of stringent laws to take actions against defaulters encouraged borrowers
to actually default willingly. The businessmen would default and then later file applications
with the Board for Industrial and Financial Reconstruction (BIFR) to prevent the banks and
FIs to take action against them.

A crawling recovery system along with a number of legal loopholes encouraged borrowers to
commit default willingly and get away without paying any serious penalties.

 Legal impediments

The existence of a number of legal impediments prevented the banks and FIs to recover the
NPAs. To take control of the securities deposited with them by the borrowers, the banks and
FIs had to approach the civil courts which were often a very time consuming and costly

 No sharing of information

In the protectionist era information was protected by banks and FIs and rarely shared with
others. It was thought that information sharing would lead to loss of core competencies and
customers. As a result there was virtually no cooperation between various institutions to keep
the NPAs under check. Common defaulters would take loans from different institutes as their
background information was rarely shared.

 Imprudent lending norms

The norms followed by banks and FIs were not in tune with international best practices.
Many discrepancies existed in lending procedures observed by banks and FIs which often led
to defaults which in other cases could have been avoided.

Also, poverty elevation programs launched by the government failed on various grounds in
meeting their objectives. The huge amount of loan granted under these schemes by public
sector banks was totally unrecoverable due to political manipulation, misuse of funds and
non-reliability of target audience of these sections. Credit allocation became 'Loan Melas',
loan proposal evaluations were slack and as a result repayment was very poor.

 Increase market share

There was huge competition between public and private sector banks and FIs to increase
market share and register loan growths in their balance sheets. As a result aggressive lending
policies were observed to grab larger market shares. “Push” policies were undertaken by
various institutions. Lending norms were relaxed which led to loan being granted to
incredible borrowers and ultimately increase in NPAs.

 Natural calamities

This is the measure factor, which is creating alarming rise in NPAs of the PSBs. every now
and then India is hit by major natural calamities thus making the borrowers unable to pay
back there loans. Thus the bank has to make large amount of provisions in order to
compensate those loans, hence end up the fiscal with a reduced profit. Mainly ours framers
depends on rain fall for cropping. Due to irregularities of rain fall the framers are not to
achieve the production level thus they are not repaying the loans.
Non Performing Assets A non-performing asset (NPA) is a loan or an advance where;

• Interest and/ or installment of principal remain overdue for a period of more than 90
days in respect of a term loan.

• the account remains ‘out of order’ in respect of an Overdraft/Cash Credit (OD/CC)

• The bill remains overdue for a period of more than 90 days in the case of bills
purchased and discounted.

Income Recognition provision

• Income from non-performing assets (NPA) is not recognized on accrual basis but is
booked as income only when it is actually received

• Institute Of Chartered Accountants of India (ICAI) requires that the revenue that
arises from the use of enterprise resources by others yielding interest should be
recognized only when there is no significant uncertainty as to its measurability or
collect ability.

• Interest on advances against term deposits, NSCs, IVPs, KVPs and Life policies may
be taken to income account on the due date, provided adequate margin is available in
the accounts.

• Fees and commissions earned by the banks as a result of re-negotiations or

rescheduling of outstanding debts should be recognized on an accrual basis over the
period of time covered by the re-negotiated or rescheduled extension of credit

• If Government guaranteed advances become NPA, the interest on such advances

should not be taken into income account unless the interest has been realized.

1. Movement towards Recommendation of movement towards International

International Practices- practices has been accepted in Principle.
introduction of norm of 90
Preconditions before implementing the
days by the year 2002

 Calculation of interest at monthly basis by


 100% computerization of banks operation

 Necessary to tone up legal machinery for

speedy disposal of collateral taken as security
for the advance.

General provision of 1% on Standard To start with a general provision on standard assets of a

assets should be introduced by RBI. minimum of 0.25% from the year ended March
31,2000 introduced.

In case of future loans, income

recognition provisions should apply
even to Government guaranteed
advances in the same manner as for
any other advance.


• An Adequate capital fund is needed by all banks to bring about solidarity ,scope,
operation which forms the ultimate strength to a bank.

• The need for Possessing healthy capital adequacy requirements is essential for
boosting the confidence of the savers.


• The Committee on banking regulations and supervisory practices (Basel Committee)
had released the guidelines on capital measures and capital standards in July 1988,
which were being accepted by central banks in various countries including RBI.In
India it has been implemented by RBI w.e.f 1.4.92.


• The Fundamental Objective behind these norms is to strengthen the soundness and
stability of banking system.


• To asses the adequacy of capital based on the quality of assets the capital adequacy
ratios (CAR) are now being focussed upon.


• Existing Banks 09 %

• New Private Sector Banks 10%

• Banks under taking Insurance business 10%

• Local area Banks 15%


• It is defined as measure of the amount of a banks capital expressed as a percentage of

its risk weighted assets. That is,


• This ratio indicates a banks ability to maintain equity capital sufficient to pay
depositors whenever they demand their money.


• CAR is the ratio which determines the capacity of the bank in terms of meeting the
time liabilities and other risks such as credit risk, operational risk etc.
• In the simplest formulation a banks capital is the cushion for potential losses which
protect the banks depositors or other lenders.

• Banking Regulators in most countries define and monitor CAR to protect depositors
,thereby maintaining confidence in the banking system.


The Basel committee has defined capital in two Tiers:

• Tier I Capital-or core capital which provides the most permanent and readily available
support against unexpected losses.

• TierII Capital-consist of elements that are not permanent in nature or are not readily


• Paid –up capital

• Statutory reserves

• Disclosed free reserves

• Capital Reserves representing surplus arising out of sale proceeds of assets.


• Equity investments in subsidiaries

• Intangible assets

• Losses in current period and those brought forward from previous period.


• Undisclosed reserves and cumulative perpetual preference shares.

• Revaluation reserves at a discount of 55% while inclusion in TierII capital).

• General provisions and loss reserves up to maximum of 1.25% of weighted risk

• Hybrid debt capital instruments (say bonds).

• Subordinated debt. (long term unsecured loans).


• weighted aggregate funded and non funded assets.

• Banks’ investments in all securities should be assigned a risk weight of 2.5 percent for
market risk.

• value of each asset/ item shall be multiplied by the relevant weights.

• Risk Adjusted Assets: w1A1 + w2A2 + …W4a


• Measure of the amount of a banks assets, adjusted for risk.

• Comparing the amount of capital a bank has with the amount of its assets gives a
measure of how able the bank is to absorb losses.

• By adjusting the amount of each loan for an estimate of how risky it is, we can
transform this percentage into a rough measure of the financial stability of a bank.


Items of asset & liability Risk Weights

1. Notes & coins, Govt securities 0%

2. Public Entities, balances with RBI, 20%


3. Secured Residential Lending. 50%

4. Commercial and consumer loans 100%


Market risk should also be taken into Risk weight of 2.5% for market risk has
account with credit risk. been introduced.

5% weight for market risk for Govt & Percentage of banks portfolio of Govt &
approved securities. securities has been increased

Risk weight for a Govt should be the Risk weight of 20% on advances has been
same as for other advances. introduced

Additional capital requirement of 5% of Risk weight of 100% has been introduced

the foreign open position limit. for foreign exchange.

Minimum capital to risk asset ratio be CRAR for banks has been enhanced to 9%


 Sale of equity and bond capital invested by the government

 Sale of government’s loan capital

• Rapid economic growth

• Return on investment
• Redistribution of income
• Employment opportunities
• Balanced development
• Small-scale and ancillary industries
• Promote import substitutions

1. Arms and Ammunition and allied items of defence equipment

2. Atomic energy
3. Iron and Steel
4. Heavy casting and forging of steel items
5. Heavy plant and machinery required for iron and steel production, for mining for
machine tool manufacture and such other industries as may be specified by the
Central Government.
6. Heavy electrical plant including large hydraulic and steam turbines
7. Coal and lignite
8. Minerals oils
9. Mining of iron ore, manganese ore, chrome ore, gypsum, sulphur, gold and diamond.
10. Mining and processing copper, lead, zinc, tin molybdenum and wolfram
11. Minerals specified in the Schedule to the Atomic Energy (Control of Production and
Use) Order 1953.
12. Aircraft
13. Air transport
14. Rail transport
15. Ship building
16. Telephones and telephone cables, telegraph and wireless apparatus (excluding radio
receiving sets)
17. Generation and distribution of electricity


1. Arms and Ammunition and allied items of defence equipment, defence aircraft and
2. Atomic Energy
3. Coal and Lignite
4. Mineral Oils
5. Mining of iron ore, manganese ore, chrome ore, gypsum, sulphur, gold and diamond
6. Mining of copper, lead, zinc, tin, molybdenum and wolfram
7. Minerals specified in the schedule to Atomic Energy (Control of production and use)
Order, 1953
8. Railway Transport
 Atomic Energy
 Minerals specified in schedule to atomic Energy (Control of Production and Use)
Order, 1953
 Railway Transport


 Releasing large amount of public resources
 Reducing further outflow of public resources
 Reducing the public debt
 Transfer of Commercial Risk
 Releasing other tangible and intangible resources


 Expose the privatised companies to market discipline
 Wider distribution of wealth
 Effect on the Capital Market
 Increase in Economic Activity
 Greater consumer satisfaction



o Disinvestment Up to 20% of the Equity in selected PSEs in favor of Public Sector

Institutional Investor
Rangarajan Committee April 1993

 It recommended 49% of PSEs Equity to be disinvested for industries explicitly

reserved for the public sector
 74% disinvestment in exceptional cases
 100% disinvestment in other cases
United Front Government Policy 1996

 Examine the public sector non-core strategic areas.

 Setting up of Disinvestment Commission
 Transparency

o Disinvestment Commission made recommendation on 58 PSEs

o Shift from public offering to strategic sales with transfer of management.

o Government shareholding to 26% in generality of cases

1999-2000 Policy

o Strengthen strategic PSU and privatize non-strategic PSU

o The expression “Privatization” used for the first time.
Strategic & Non-strategic Classification

March 1999

• 3 industries were strategic industries and rest all the industries were non strategic.
• Percentage of disinvestment change in government stake going down to less 51% or
up to 26% would be case to case.
Budget 2000 - 2001

• First time government was ready to reduce the stake below 26% in a Non Strategic

o Restructuring assistance to PSU

o Safety net to workers
o Reduction of debt burden

 Net Asset Method

 Profit Earning Capacity Valuation Method
 Discounted Cash Flow Method


• The return on investments in PSEs, at least for the last two decades, has been quite
• The PSE Survey shows PSEs, as a whole, never earned post tax profits that exceeded
5% of total sales or 6% of capital employed,which is at least 3% points below the
interest paid by the Government on its borrowings
Recurring Budgetary support to PSEs:

• Despite huge investment in the public sector, the Government is required to provide
more funds every year that go into maintaining of the unviable / weak PSEs
Cost Control:
 The cost structure in PSEs is increasing as compared to private sector, which is able to
contain costs on all parameters.
Industrial Sickness in PSUs:
• To save the PSUs from sickness, the government has been sanctioning restructuring
packages from time to time.
• As on 31.3.00 Profit & Loss A/C of 21 PSUs showed accumulated loss of 13959.57
Employee issues:

• Of the 1.6 million jobs added in the organized sector 1 million, or two thirds, were
added in the private sector during the period 1991 to 2000.
• This indicates that the private sector has become the major source for incremental
employment in the organized sector of the economy over the last decade

 Strategic Sale
 Optimization by getting competitive bids
 Regulated by Company’s Act SEBI, RBI Stock Exchange and FIPB
clearance (for foreign investors)
 Suitable for:
 Non-strategic companies
 where government is willing to give significant
management control

Offer for Sale to Offer For Sale To
Public Public Through Secondary Market
Particulars at Fixed Price Book Building Operation

Optimized, since
Decided before the price is discovered
transaction, at a through a bidding
Pricing discount to market process At market prices

Mix of retail and

wholesale, with Essentially Essentially
Target Investor some reservation wholesale but small wholesale could be
Set for small investors investor also retail investor also

High, in the range High, in the range

of of
2-5% depending on 2-5% depending on Low, in terms of
Transaction Cost issue size issue size brokerage

Time Involved 3 - 4 months 3 - 4 months Spot transactions

SEBI guidelines, SEBI guidelines,

Stock Exchange Stock Exchange Stock Exchange
Regulation requirements requirements requirements

Private Placement of
Particulars International Offering Equity Auction
Valuation by merchant
banker and feedback from
institutional investors or optimised
price discovered through through
Pricing Valuation by QIBs book building bidding

Essentially institutional
Target including private equity Essentially
Investor Set FII funds institutional

High, in the range of 2-

Transaction 5% depending on issue
Cost size Low Low

Involved 3-5 months 1-2 months 1-2 months

Disclosure requirements
by Securities Exchange
Commission (SEC) and
accounting in accordance
with US Generally
Accepted Accounting Foreign investment
Practices (GAAP) (for guidelines in case of
ADRs), NASDAQ / overseas investors, SEBI
NYSE/ LSE listing guidelines in case of SEBI Take-
Regulation requirements domestic listed companies over code

 Offer For Sale To Public Through Book Building
 Suitability:
 Companies for which institutional interest is expected to be substantial
 Profit making companies with good intrinsic value and future
 Companies not in need of significant technical, managerial, marketing
 Secondary Market Operation
 Suitability:
 Companies which have a sizeable floating stock with good intrinsic
value and good future prospects
 Companies not in need of significant technical, managerial, marketing
inputs etc.
 International Offering
 Suitability
 Companies which have stocks listed in the international markets or
companies with actively traded stock in domestic markets
 Companies with good intrinsic value, good future prospects and of
international repute
 Private Placement of Equity
 Suitability
 Unlisted companies
 Listed companies with low floating stock and low volumes
 Companies with good intrinsic value and good future prospects
 Auction
 Suitability
 Companies with good intrinsic value
 Unlisted companies
 Listed companies with low floating stock

• Trade Sale
• Asset Sale and Winding up
• Sale through Demerger/Spinning off

Economies of Investment Trust Companies

Institutions that pool savings of the people, by the issue of stocks & debentures, in order to
make investment of these resources in the wide range of industrial securities are called
investment companies.
These are also known as Mutual Funds
Working of MF


Returns Securities

Features of Investment Trust Companies (Mutual Funds):

 Purpose

 Help Small Savers

 Expert Advice


 Management Investment Companies

These are those companies that exercise their power on the choice of the composition of their
investment portfolio.

 Unit Trust

It is designed to pool the savings of small investor by the sale of its unit and employ the
saving in corporate and other securities in order to earn safe and fair return.

Advantages of Mutual Funds:

 Portfolio Diversification

 Professional Management

 Reduction/Diversification of Risk

 Reduction of Transaction Costs

 Convenience & Flexibility

 Safety

Disadvantages of Mutual Funds:

 No Control Over Costs

 No Tailor Made Portfolios

 Managing a Portfolio of Funds

Special Legal Structure of Mutual Funds

 Unique structure

 Funds Constituents

 Sponsor,

 Trustee,

 Custodian, etc.

MF Structure in the USA

 MFs are set up as investment companies.

 Investment Company appoints a

Management Company.

 MFs are regulated by Securities & Exchange Commission (equivalent of SEBI).

MF Structure in the UK

 MFs have two alternative structure

 Open – end funds in the form of Unit Trusts.

 Closed – end funds in the form of Investments Trusts.

MF Structure in India

 Like other countries, India has a legal framework within which MFs must be

 Open end & closed end funds are constituted under one unique structure – Unit

 Regulated by SEBI (MF) Regulation, 1996.

MF Constituents
The Fund Sponsor

 SEBI defines sponsor as any person who, acting alone or in combination with another
body corporate, establishes a MF.

 Sponsor should contribute at least 40% of net worth of AMC.

Mutual Funds as Trusts

 Constituted in the form of Public Trust under Indian Trusts Act, 1882.

 Sponsor contributes initial capital & appoints a Trustee.

 Then the funds invites investors to contribute their money.


 MFs managed by a Board of Trustees (BoT).

 BoT is constituted of two – third of independent directors as mandated by SEBI.

 Trust is created through a Trust Deed.

Rights of Trustees

 Appoint AMC with approval of SEBI.

 Approve each of the scheme of AMC.

 Have the right to request any necessary information from AMC concerning the
operations of various schemes.

 May take remedial action.

 May even dismiss the AMC.

Obligations of Trustees

 Must enter into an investment management agreement with the AMC.

 Ensure funds transaction in accordance with the Trust Deed.

 Due diligence on the part of the AMC for Empanelment of brokers.

 Must furnish half – yearly reports to SEBI.

 Role is to act as investment manager.

 Is appointed by sponsor or trustees.

 Floats & manages different investment schemes.

 Must have a net worth of at least 10 crores at all times.

Other Fund Constituents

 Custodian & depositories

 Bankers

 Registrars & Transfer Agents

 Distributors

Structure of a MF

Managed by a BoT

Sponsor Company (establishes the MF as a trust)

(e.g. ICICI Prudential)

Mutual Fund (hold unit holders funds in MF) (e.g.

Reliance Mutual Fund)

AMC (Floats & manages MF) (e.g. Reliance AMC)

Custodian (provides custodial services)

Registrar (provides registrar & transfer services)

Distributors (provides network for distribution

of the scheme)
Mutual Fund Classifications:

 Open end & Closed end funds

 Load & no load funds

 Tax exempt & Non Tax exempt funds

Mutual Fund Types:

 Money Market/Liquid Funds

 Gilt Funds

 Debt Funds

 Equity Funds

 Hybrid Funds (Quasi Equity/Quasi Debt)

 Commodity Funds

 Real Estate Funds

 Fund of Funds

Accounting of Mutual Funds:

Net Asset Value (NAV) = Net assets of the scheme/Number of Units Outstanding

Net Assets mean Market Value of Investments + Receivables + Other Accrued

Income + Other Assets (include cash) – Accrued Payables – Other Payables & Liabilities


An open end fund with 10,000 units outstanding has following items in the balance sheet:

Investments at market value Rs. 1,00,000

Other assets Rs. 20,000

Liabilities Rs. 25,000

NAV = Rs. 9.5 per unit.

Tax Provisions:

 Generally, income earned by any MF is exempt from tax u/s 10 (23D) of Income Tax
Act, 1961.
 However, income distributed by closed end or debt fund is liable to a Dividend
Distribution Tax.

 DDT is not applicable to open end equity oriented funds.

 Income distributed by a fund is exempted in the hands of investors.

QUES -1 What is a Non-Banking Financial Company (NBFC)?

ANS -1 A Non-Banking Financial Company (NBFC) is a company registered under the

Companies Act, 1956 and is engaged in the business of loans and advances, acquisition of
shares/stock/bonds/debentures/securities issued by Government or local authority or other
securities of like marketable nature, leasing, hire-purchase, insurance business, chit business
but does not include any institution whose principal business is that of agriculture activity,
industrial activity, sale/purchase/construction of immovable property. A non-banking
institution which is a company and which has its principal business of receiving deposits
under any scheme or arrangement or any other manner, or lending in any manner is also a
non-banking financial company (Residuary non-banking company).

QUES 2. NBFCs are doing functions similar to banks. What is difference between banks &

ANS 2. NBFCs are doing functions akin to that of banks; however there are a few

(i) an NBFC cannot accept demand deposits;

(ii) an NBFC is not a part of the payment and settlement system and as such an NBFC
cannot issue cheques drawn on itself; and

(iii) deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation
is not available for NBFC depositors unlike in case of banks.

QUES-3. Is it necessary that every NBFC should be registered with RBI?

ANS 3. In terms of Section 45-IA of the RBI Act, 1934, it is mandatory that every NBFC
should be registered with RBI to commence or carry on any business of non-banking
financial institution as defined in clause (a) of Section 45 I of the RBI Act, 1934.

However, to obviate dual regulation, certain categories of NBFCs which are regulated by
other regulators are exempted from the requirement of registration with RBI viz. Venture
Capital Fund/Merchant Banking companies/Stock broking companies registered with SEBI,
Insurance Company holding a valid Certificate of Registration issued by IRDA, Nidhi
companies as notified under Section 620A of the Companies Act, 1956, Chit companies as
defined in clause (b) of Section 2 of the Chit Funds Act, 1982 or Housing Finance Companies
regulated by National Housing Bank.

QUES 4. What are the different types of NBFCs registered with RBI?

ANS 4. Originally, NBFCs registered with RBI were classified as:

(i) equipment leasing company;

(ii) hire-purchase company;
(iii) loan company;
(iv) investment company.

However, with effect from December 6, 2006 the above NBFCs registered with RBI have
been reclassified as

(i) Asset Finance Company (AFC)

(ii) Investment Company (IC)
(iii) Loan Company (LC)

AFC would be defined as any company which is a financial institution carrying on as its
principal business the financing of physical assets supporting productive/economic activity,
such as automobiles, tractors, lathe machines, generator sets, earth moving and material
handling equipments, moving on own power and general purpose industrial machines.
Principal business for this purpose is defined as aggregate of financing real/physical assets
supporting economic activity and income arising therefrom is not less than 60% of its total
assets and total income respectively.
The above type of companies may be further classified into those accepting deposits or those
not accepting deposits.

QUES 5. What are the requirements / is the procedure for registration with RBI?

ANS 5. A company incorporated under the Companies Act, 1956 and desirous of
commencing business of non-banking financial institution as defined under Section 45 I(a) of
the RBI Act, 1934 should have a minimum net owned fund of Rs 25 lakh (raised to Rs 200
lakh w.e.f April 21, 1999).

The company is required to submit its application online by accessing RBI’s secured
website https://secweb.rbi.org.in/COSMOS/rbilogin.do (the applicant companies do not need
to log on to the COSMOS application and hence user ids for these companies are not
required). The company has to click on “CLICK” for Company Registration on the login
page. A window showing the Excel application forms available for download would be
displayed. The company can then download suitable application form (i.e. NBFC or SC/RC)
from the above website, key in the data and upload the application form. The company may
note to indicate the name of the correct Regional Office in the field “C-8” of the “Annx-
Identification Particulars” worksheet of the Excel application form. The company would then
get a Company Application Reference Number for the CoR application filed on-line.
Thereafter, the company has to submit the hard copy of the application form (indicating the
Company Application Reference Number of its on-line application), along with the
supporting documents, to the concerned Regional Office. The company can then check the
status of the application based on the acknowledgement number. The Bank would issue
Certificate of Registration after satisfying itself that the conditions as enumerated in Section
45-IA of the RBI Act, 1934 are satisfied.

QUES 6. Where can one find list of Registered NBFCs and instructions issued to NBFCs?

ANS 6. The list of registered NBFCs is available on the web site of Reserve Bank of India
and can be viewed at www.rbi.org.in. The instructions issued to NBFCs from time to time are
also hosted at the above site. Besides, instructions are also issued through Official Gazette
notifications. Press Release is also issued to draw attention of the public/NBFCs.
QUES 7. Can all NBFCs accept deposits and what are the requirements for accepting Public

ANS 7. All NBFCs are not entitled to accept public deposits. Only those NBFCs holding a
valid Certificate of Registration with authorisation to accept Public Deposits can accept/hold
public deposits. NBFCs authorised to accept/hold public deposits besides having minimum
stipulated Net Owned Fund (NOF) should also comply with the Directions such as investing
part of the funds in liquid assets, maintain reserves, rating etc. issued by the Bank.

QUES 8. Is there any ceiling on acceptance of Public Deposits? What is the rate of interest
and period of deposit which NBFCs can accept?

ANS 8. Yes, there is a ceiling on acceptance of Public Deposits. An NBFC maintaining

required NOF/Capital to Risk Assets Ratio (CRAR) and complying with the prudential norms
can accept public deposits as follows:

Category of NBFC having minimum Ceiling on public

NOF of Rs 200 lakhs deposit
AFC* maintaining CRAR of 15% without credit rating 1.5 times of NOF or Rs 10
crore whichever is less

AFC with CRAR of 12% and having minimum investment grade

4 times of NOF
credit rating
LC/IC** with CRAR of 15% and having minimum investment 1.5 times of NOF
grade credit rating

* AFC = Asset Finance Company

** LC/IC = Loan company/Investment Company

As has been notified on June 17, 2008 the ceiling on level of public deposits for NBFCs
accepting deposits but not having minimum Net Owned Fund of Rs 200 lakh is revised as

Category of NBFC having NOF more Revised Ceiling on public

than Rs 25 lakh but less than Rs 200 lakh deposits
AFCs maintaining CRAR of 15% without credit rating and Equal to NOF
AFCs with CRAR of 12% and having minimum investment 1.5 times of NOF
grade credit rating
LCs/ICs with CRAR of 15% and having minimum investment Equal to NOF
grade credit rating

Presently, the maximum rate of interest an NBFC can offer is 12.5%. The interest may be
paid or compounded at rests not shorter than monthly rests.

The NBFCs are allowed to accept/renew public deposits for a minimum period of 12 months
and maximum period of 60 months. They cannot accept deposits repayable on demand.

The RNBCs have different norms for acceptance of deposits which are explained elsewhere
in this booklet.

QUES 9. What are the salient features of NBFCs regulations which the depositor may note
at the times of investment?

ANS 9. Some of the important regulations relating to acceptance of deposits by NBFCs are
as under:

i. The NBFCs are allowed to accept/renew public deposits for a minimum period of 12
months and maximum period of 60 months. They cannot accept deposits repayable on
ii. NBFCs cannot offer interest rates higher than the ceiling rate prescribed by RBI from
time to time. The present ceiling is 12.5 per cent per annum. The interest may be paid
or compounded at rests not shorter than monthly rests.
iii. NBFCs cannot offer gifts/incentives or any other additional benefit to the depositors.
iv. NBFCs (except certain AFCs) should have minimum investment grade credit rating.
v. The deposits with NBFCs are not insured.
vi. The repayment of deposits by NBFCs is not guaranteed by RBI.
vii. Certain mandatory disclosures are to be made about the company in the Application
Form issued by the company soliciting deposits.
QUES 10. What is ‘deposit’ and ‘public deposit’? Is it defined anywhere?

ANS 10. The term ‘deposit’ is defined under Section 45 I(bb) of the RBI Act, 1934. ‘Deposit’
includes and shall be deemed always to have included any receipt of money by way of
deposit or loan or in any other form but does not include:

 amount raised by way of share capital, or contributed as capital by partners of a firm;

 amount received from scheduled bank, co-operative bank, a banking company, State
Financial Corporation, IDBI or any other institution specified by RBI;
 amount received in ordinary course of business by way of security deposit, dealership
deposit, earnest money, advance against orders for goods, properties or services;
 amount received by a registered money lender other than a body corporate;
 amount received by way of subscriptions in respect of a ‘Chit’.

Paragraph 2(1)(xii) of the Non-Banking Financial Companies Acceptance of Public Deposits

( Reserve Bank) Directions, 1998 defines a ‘ public deposit’ as a ‘deposit’ as defined under
Section 45 I(bb) of the RBI Act, 1934 and further excludes the following:

 amount received from the Central/State Government or any other source where
repayment is guaranteed by Central/State Government or any amount received from
local authority or foreign government or any foreign citizen/authority/person;
 any amount received from financial institutions;
 any amount received from other company as inter-corporate deposit;
 amount received by way of subscriptions to shares, stock, bonds or debentures
pending allotment or by way of calls in advance if such amount is not repayable to the
members under the articles of association of the company;
 amount received from shareholders by private company;
 amount received from directors or relative of the director of an NBFC;
 amount raised by issue of bonds or debentures secured by mortgage of any
immovable property or other asset of the company subject to conditions;
 the amount brought in by the promoters by way of unsecured loan;
 amount received from a mutual fund;
 any amount received as hybrid debt or subordinated debt;
 any amount received by issuance of Commercial Paper.

Thus, the directions exclude from the definition of public deposit, amount raised from certain
set of informed lenders who can make independent decision.

QUES 11. Are Secured debentures treated as Public Deposit? If not who regulates them?

ANS 11. Debentures secured by the mortgage of any immovable property or other asset of
the company, if the amount raised does not exceed the market value of the said immovable
property or other asset, are excluded from the definition of ‘Public Deposit’ in terms of Non-
Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions,
1998. Secured debentures are debt instruments and are regulated by Securities & Exchange
Board of India.

QUES 12. Whether NBFCs can accept deposits from NRIs?

ANS 12. Effective from April 24, 2004, NBFCs cannot accept deposits from NRIs except
deposits by debit to NRO account of NRI provided such amount does not represent inward
remittance or transfer from NRE/FCNR (B) account. However, the existing NRI deposits can
be renewed.

QUES 13 Is nomination facility available to the Depositors of NBFCs?

ANS 13. Yes, nomination facility is available to the depositors of NBFCs. The Rules for
nomination facility are provided for in section 45QB of the Reserve Bank of India Act, 1934.
Non-Banking Financial Companies have been advised to adopt the Banking Companies
(Nomination) Rules, 1985 made under Section 45ZA of the Banking Regulation Act, 1949.
Accordingly, depositor/s of NBFCs are permitted to nominate one person to whom the NBFC
can return the deposit in the event of the death of the depositor/s. NBFCs are advised to
accept nominations made by the depositors in the form similar to one specified under the said
rules, viz Form DA 1 for the purpose of nomination, and Form DA2 and DA3 for
cancellation of nomination and change of nomination respectively.

QUES 14. What else should a depositor bear in mind while depositing money with NBFCs?
ANS 14. While making deposits with an NBFC, the following aspects should be borne in

(i) Public deposits are unsecured.

(ii) A proper deposit receipt which should, besides the name of the depositor/s, state
the date of deposit, the amount in words and figures, rate of interest payable and the
date of maturity. Depositor/s should insist on the above and also ensure that the
receipt is duly signed by an officer authorised by the company in that behalf.
(iii) The Reserve Bank of India does not accept any responsibility or guarantee about
the present position as to the financial soundness of the company or for the
correctness of any of the statements or representations made or opinions expressed by
the company and for repayment of deposits/discharge of the liabilities by the
QUES 15. It is said that rating of NBFCs is necessary before it accepts deposit? Is it true?
Who rates them?

ANS 15. An unrated NBFC, except certain Asset Finance companies (AFC), cannot accept
public deposits. An exception is made in case of unrated AFC companies with CRAR of
15% which can accept public deposit without having a credit rating upto a certain ceiling
depending upon its Net Owned Funds (c.f Ans to Q 8). AN NBFC may get itself rated by
any of the four rating agencies namely, CRISIL, CARE, ICRA and FITCH Ratings India Pvt.

QUES 16. What are the symbols of minimum investment grade rating of different

ANS 16. The symbols of minimum investment grade rating of the Credit rating agencies are:

Name of rating agencies Nomenclature of minimum investment

grade credit rating (MIGR)
FITCH Ratings India Pvt. Ltd. tA-(ind)(FD)
It may be added that A- is not equivalent to A, AA- is not equivalent to AA and AAA- is not
equivalent to AAA.

QUES 17. Can an NBFC which is yet to be rated accept public deposit?

ANS 17. No, an NBFC cannot accept deposit without rating (except an Asset Finance
Company complying with prudential norms and having CRAR of 15%, as explained above
at Ans. to Q 8).

QUES 18. When a company’s rating is downgraded, does it have to bring down its level of
public deposits immediately or over a period of time?

ANS 18. If rating of an NBFC is downgraded to below minimum investment grade rating, it
has to stop accepting public deposit, report the position within fifteen working days to the
RBI and reduce within three years from the date of such downgrading of credit rating, the
amount of excess public deposit to nil or to the appropriate extent permissible under
paragraph 4(4) of Non-Banking Financial Companies Acceptance of Public Deposits
(Reserve Bank) Directions, 1998.

QUES 19. In case an NBFC defaults in repayment of deposit what course of action can be
taken by depositors?

ANS 19. If an NBFC defaults in repayment of deposit, the depositor can approach Company
Law Board or Consumer Forum or file a civil suit in a court of law to recover the deposits.

QUES 20. What is the role of Company Law Board in protecting the interest of depositors?
How one can approach it?

ANS 20. Where an NBFC fails to repay any deposit or part thereof in accordance with the
terms and conditions of such deposit, the Company Law Board (CLB) either on its own
motion or on an application from the depositor, directs by order the non-banking financial
company to make repayment of such deposit or part thereof forthwith or within such time and
subject to such conditions as may be specified in the order.
As explained above, the depositor can approach CLB by mailing an application in prescribed
form to the appropriate bench of the Company Law Board according to its territorial
jurisdiction alongwith the prescribed fee.

QUES 22. We hear that in a number of cases official liquidators have been appointed on the
defaulting NBFCs. What is their role and how one can approach them?

ANS 22. Official Liquidator is appointed by the court after giving the company reasonable
opportunity of being heard in a winding up petition. The liquidator performs duties of
winding up and such duties in reference thereto as the court may impose.
Where the court has appointed an official liquidator or provisional liquidator, he becomes
custodian of the property of the company and runs the day-to-day affairs of the company. He
has to draw up a statement of affairs of the company in prescribed form containing particulars
of assets of the company, its debts and liabilities, names/residences/occupations of its
creditors, the debts due to the company and such other information as may be prescribed. The
scheme is drawn up by the liquidator and same is put up to the court for approval. The
liquidator realizes the assets of the company and arranges to repay the creditors according to
the scheme approved by the court. The liquidator generally inserts advertisement in the
newspaper inviting claims from depositors/investors in compliance with court orders.
Therefore, the investors/depositors should file the claims within due time as per such notices
of the liquidator. The Reserve Bank also provides assistance to the depositors in furnishing
addresses of the official liquidator.

QUES 23. Consumer Court play useful role in attending to depositors problems. Can one
approach Consumer Forum, Civil Court, CLB simultaneously?

ANS 23. Yes, a depositor can approach any or all of the redressal authorities i.e consumer
forum, court or CLB.

QUES 24. Is there an Ombudsman for hearing complaints against NBFCs?

ANS 24. No, there is no Ombudsman for hearing complaints against NBFCs. However, in
respect of credit card operations of an NBFC, if a complainant does not get satisfactory
response from the NBFC within a maximum period of thirty (30) days from the date of
lodging the complaint, the customer will have the option to approach the Office of the
concerned Banking Ombudsman for redressal of his grievance/s.

QUES 25. What are various prudential regulations applicable to NBFCs?

ANS 25. The Bank has issued detailed directions on prudential norms, vide Non-Banking
Financial Companies Prudential Norms (Reserve Bank) Directions, 1998. The directions
interalia, prescribe guidelines on income recognition, asset classification and provisioning
requirements applicable to NBFCs, exposure norms, constitution of audit committee,
disclosures in the balance sheet, requirement of capital adequacy, restrictions on investments
in land and building and unquoted shares.

QUES 26. Please explain the terms ‘owned fund’ and ‘net owned fund’ in relation to

ANS 26. ‘Owned Fund’ means aggregate of the paid-up equity capital and free reserves as
disclosed in the latest balance sheet of the company after deducting therefrom accumulated
balance of loss, deferred revenue expenditure and other intangible assets.
'Net Owned Fund' is the amount as arrived at above minus the amount of investments of such
company in shares of its subsidiaries, companies in the same group and all other NBFCs and
the book value of debentures, bonds, outstanding loans and advances made to and deposits
with subsidiaries and companies in the same group, to the extent it exceeds 10% of the owned

QUES 27. What are the responsibilities of the NBFCs accepting/holding public deposits
with regard to submission of Returns and other information to RBI?

ANS 27. The NBFCs accepting public deposits should furnish to RBI

i. Audited balance sheet of each financial year and an audited profit and loss account in
respect of that year as passed in the annual general meeting together with a copy of
the report of the Board of Directors and a copy of the report and the notes on accounts
furnished by its Auditors;
ii. Statutory Annual Return on deposits - NBS 1;
iii. Certificate from the Auditors that the company is in a position to repay the deposits
as and when the claims arise;
iv. Quarterly Return on liquid assets;
v. Half-yearly Return on prudential norms;
vi. Half-yearly ALM Returns by companies having public deposits of Rs. 20 crore and
above or with assets of Rs. 100 crore and above irrespective of the size of deposits ;
vii. Monthly return on exposure to capital market by companies having public deposits
of Rs. 50 crore and above; and
viii. A copy of the Credit Rating obtained once a year along with one of the Half-yearly
Returns on prudential norms as at (v) above.

QUES 28. What are the documents or the compliance required to be submitted to the
Reserve Bank of India by the NBFCs not accepting/holding public deposits?

ANS 28. The NBFCs having assets of Rs. 100 crore and above but not accepting public
deposits are required to submit a Monthly Return on important financial parameters of the
company. All companies not accepting public deposits have to pass a board resolution to the
effect that they have neither accepted public deposit nor would accept any public deposit
during the year.

However, all the NBFCs (other than those exempted) are required to be registered with RBI
and also make sure that they continue to be eligible to retain the Registration. Further, all
NBFCs (including non-deposit taking) should submit a certificate from their Statutory
Auditors every year to the effect that they continue to undertake the business of NBFI
requiring holding of CoR under Section 45-IA of the RBI Act, 1934.

RBI has powers to cause Inspection of the books of any company and call for any other
information about its business activities. For this purpose, the NBFC is required to furnish the
information in respect of any change in the composition of its Board of Directors, address of
the company and its Directors and the name/s and official designations of its principal
officers and the name and office address of its Auditors. With effect from April 1, 2007, non-
deposit taking NBFCs with assets of Rs 100 crore and above were advised to maintain
minimum CRAR of 10% and also comply with single/group exposure norms. The companies
have to achieve CRAR of 12% by March 31, 2009 and 15% by March 31, 2010.
QUES 29. The NBFCs have been made liable to pay interest on the overdue matured
deposits if the company has not been able to repay the matured public deposits on receipt of a
claim from the depositor. Please elaborate the provisions.

ANS 29. As per Reserve Bank’s Directions, overdue interest is payable to the depositors in
case the company has delayed the repayment of matured deposits, and such interest is
payable from the date of receipt of such claim by the company or the date of maturity of the
deposit whichever is later, till the date of actual payment. If the depositor has lodged his
claim after the date of maturity, the company would be liable to pay interest for the period
from the date of claim till the date of repayment. For the period between the date of maturity
and the date of claim it is the discretion of the company to pay interest.

QUES 30. Can a company pre-pay its public deposits?

ANS 30. AN NBFC accepts deposits under a mutual contract with its depositors. In case a
depositor requests for pre-mature payment, Reserve Bank of India has prescribed Regulations
for such an eventuality in the Non-Banking Financial Companies Acceptance of Public
Deposits (Reserve Bank) Directions, 1998 wherein it is specified that NBFCs cannot grant
any loan against a public deposit or make premature repayment of a public deposit within a
period of three months (lock-in period) from the date of its acceptance. However, in the event
of death of a depositor, the company may, even within the lock-in period, repay the deposit at
the request of the joint holders with survivor clause / nominee / legal heir only against
submission of relevant proof, to the satisfaction of the company.

An NBFC subject to above provisions, which is not a problem company, may permit after the
lock–in period, premature repayment of a public deposit at its sole discretion, at the rate of
interest prescribed by the Bank.

A problem NBFC is prohibited from making premature repayment of any deposits or

granting any loan against public deposit/deposits, as the case may be. The prohibition shall
not, however, apply in the case of death of depositor or repayment of tiny deposits i.e. up to
Rs. 10000/- subject to lock in period of 3 months in the latter case.

QUES 31. What is the liquid asset requirement for the deposit taking companies? Where
these assets are kept? Do depositors have any claims on them?
ANS 31. In terms of Section 45-IB of the RBI Act, 1934, the minimum level of liquid asset
to be maintained by NBFCs is 15 per cent of public deposits outstanding as on the last
working day of the second preceding quarter. Of the 15%, NBFCs are required to invest not
less than ten percent in approved securities and the remaining 5% can be in unencumbered
term deposits with any scheduled commercial bank. Thus, the liquid assets may consist of
Government securities, Government guaranteed bonds and term deposits with any scheduled
commercial bank.

The investment in Government securities should be in dematerialised form which can be

maintained in Constituents’ Subsidiary General Ledger (CSGL) Account with a scheduled
commercial bank (SCB) / Stock Holding Corporation of India Limited (SHICL). In case of
Government guaranteed bonds the same may be kept in dematerialised form with
SCB/SHCIL or in a dematerialised account with depositories [National Securities Depository
Ltd. (NSDL)/Central Depository Services (India) Ltd. (CDSL)] through a depository
participant registered with Securities & Exchange Board of India (SEBI). However in case
there are Government bonds which are in physical form the same may be kept in safe custody

NBFCs have been directed to maintain the mandated liquid asset securities in a
dematerialised form with the entities stated above at a place where the registered office of the
company is situated. However, if an NBFC intends to entrust the securities at a place other
than the place at which its registered office is located, it may do so after obtaining the
permission of RBI in writing. It may be noted that liquid assets in approved securities will
have to be maintained in dematerialised form only.

The liquid assets maintained as above are to be utilised for payment of claims of depositors.
However, deposit being unsecured in nature, depositors do not have direct claim on liquid

QUES 32. Please tell us something about the companies which are NBFCs, but are exempted
from registration?

ANS 32. Housing Finance Companies, Merchant Banking Companies, Stock Exchanges,
Companies engaged in the business of stock-broking/sub-broking, Venture Capital Fund
Companies, Nidhi Companies, Insurance companies and Chit Fund Companies are NBFCs
but they have been exempted from the requirement of registration under Section 45-IA of the
RBI Act, 1934 subject to certain conditions.

Housing Finance Companies are regulated by National Housing Bank, Merchant

Banker/Venture Capital Fund Company/stock-exchanges/stock brokers/sub-brokers are
regulated by Securities and Exchange Board of India, and Insurance companies are regulated
by Insurance Regulatory and Development Authority. Similarly, Chit Fund Companies are
regulated by the respective State Governments and Nidhi Companies are regulated by
Ministry of Corporate Affairs, Government of India.

It may also be mentioned that Mortgage Guarantee Companies have been notified as Non-
Banking Financial Companies under Section 45 I(f)(iii) of the RBI Act, 1934.

QUES 33. There are some entities (not companies) which carry on activities like that of
NBFCs. Are they allowed to take deposits? Who regulates them?

ANS 33. Any person who is an individual or a firm or unincorporated association of

individuals cannot accept deposits except by way of loan from relatives, if his/its business
wholly or partly includes loan, investment, hire-purchase or leasing activity or principal
business is that of receiving of deposits under any scheme or arrangement or in any manner
or lending in any manner.

QUES 34. What is a Residuary Non-Banking Company (RNBC)? In what way it is different
from other NBFCs?

ANS 34. Residuary Non-Banking Company is a class of NBFC which is a company and has
as its principal business the receiving of deposits, under any scheme or arrangement or in any
other manner and not being Investment, Asset Financing, Loan Company. These companies
are required to maintain investments as per directions of RBI, in addition to liquid assets.
The functioning of these companies is different from those of NBFCs in terms of method of
mobilisation of deposits and requirement of deployment of depositors' funds as per
Directions. Besides, Prudential Norms Directions are applicable to these companies also.
QUES 35. We understand that there is no ceiling on raising of deposits by RNBCs, then how
safe is deposit with them?

ANS 35. It is true that there is no ceiling on raising of deposits by RNBCs but every RNBC
has to ensure that the amounts deposited and investments made by the company are not less
than the aggregate amount of liabilities to the depositors.

To secure the interest of depositor, such companies are required to invest in a portfolio
comprising of highly liquid and secure instruments viz. Central/State Government securities,
fixed deposits with scheduled commercial banks (SCB), Certificate of deposits of SCB/FIs,
units of Mutual Funds, etc.

QUES 36. Can RNBC forfeit deposit if deposit installments are not paid regularly or

ANS 36. No Residuary Non-Banking Company shall forfeit any amount deposited by the
depositor, or any interest, premium, bonus or other advantage accrued thereon.

QUES 37. Please tell us something on rate of interest payable by RNBCs on deposits and
maturity period of deposits?

ANS 37. The amount payable by way of interest, premium, bonus or other advantage, by
whatever name called by a RNBC in respect of deposits received shall not be less than the
amount calculated at the rate of 5% (to be compounded annually) on the amount deposited in
lump sum or at monthly or longer intervals; and at the rate of 3.5% (to be compounded
annually) on the amount deposited under daily deposit scheme. Further, a RNBC can accept
deposits for a minimum period of 12 months and maximum period of 84 months from the
date of receipt of such deposit. They cannot accept deposits repayable on demand.